Brian Fallow: ETS changes will depress carbon market

Changes the Government plans to make to the emissions trading scheme will reduce demand and increase supply in a market already flooded with cheap imported carbon.

They risk reducing the price signal from a pretty faint murmur now to one that is well nigh inaudible.

Whether they are a pragmatic response to geopolitical reality or a shameful disregard of geophysical reality is, of course, an issue on which opinion will divide.

The ETS limits the right to emit greenhouse gases and creates a market in permits to do so ("carbon") along the lines of fishing quotas.

It was enacted in the dying days of Labour's nine years in power and kept, but watered down, when National took office.

It has been operating in earnest for the past two years since oil companies, power companies and industrial emitters were brought into the scheme.

For the first year, the carbon price was stable at around $20 a tonne and money flowed from energy consumers to forest owners who had carbon credits to sell. The price signal was to go easy on the fossil fuel and plant more trees.

But in the past year, the price has collapsed reflecting the travails of Europe, much the largest player in the global carbon market.

By the end of last year the price had fallen to around $7 and languishes there still.

New Zealand emitters seem to have filled their boots.

The World Bank's annual report on the state of the carbon market, published just over a month ago, cites local brokers saying: "In 2011, scheme participants secured enough secondary CERs [certified emission reductions] to achieve compliance for the next two or three years given low CER prices, a strong New Zealand dollar and the scheme's 100 per cent international offset provisions."

That last bit of jargon refers to the unrestricted ability local emitters have to meet their obligations by buying and surrendering to the Government CERs - United Nations-approved carbon generated by emission-reducing projects in developing countries - instead of New Zealand units issued by the Government.

A key decision in the package of measures the Government announced last week was to reject calls to restrict emitters' ability to use imported carbon to meet their obligations, as Europe does and as Australia will when its carbon tax morphs into an ETS in 2015.

"People who want that restriction want the New Zealand price to be dislodged from the international price. We do not," says Climate Change Minister Tim Groser.

Broadly speaking, foresters wanted the restriction while business opposed it. At current prices forest owners have little incentive to sell units or to plant trees to earn more of them.

As for the potential obstacle to linking with the Australian scheme down the track, "I'm sure the 2015 review will have a look at that issue", the minister says.

The Government plans to extend, at least until the other side of that review, what were supposed to be transitional measures to soften the impact of the scheme on households and businesses.

One is the provision which allows companies with obligations under the scheme to surrender only one unit for every two tonnes of emissions for which they are liable - buy one, get one free.

That was to have expired at the end of this year.

The Caygill review recommended phasing it out by 2015, but the Government has opted to extend it indefinitely.

It has also suspended a provision which would have reduced very gradually, by 1.3 per cent a year, the free allocation of units received by large trade-exposed, emissions-intensive firms.

It is intended to limit the impact of the ETS on their international competitiveness, while still exposing them to a price of carbon at the margin.

The current law would have brought agricultural emissions, nearly half the national total, into the scheme on the same basis as other trade-exposed emitters in 2015.

But that has now been deferred indefinitely, subject to the review in 2015.

In the meantime, however, the Government will work on how to measure and report emissions at the farm level, Groser says, "so that if a future Government does decide to introduce a price on biological emissions, at least we'll know what we are doing".

No other country puts a price on biological emissions, he says, and he has reiterated the conditions his predecessor, Nick Smith, put on agriculture's inclusion: that there be practical technologies farmers could use to reduce their emissions and sufficient progress internationally on climate change mitigation.

The weasel words "practical" and "sufficient" will give farmers ample scope to argue the conditions are not met.

These amendments to the ETS will, of course, reduce the demand side of the carbon market compared with what it would have have been under the existing legislative settings.

Groser accepts that if the carbon price remains at its present low level, the economic impact of the ETS will be "very low".

But he's not ready to bet it will.

"While the Europeans are preoccupied with survival at the moment, I don't believe for one minute they will allow this situation to rest at that price, because they are serious about this."

One flick of the EU's regulatory pen could drive the price up, he says.

The Government plans to legislate to give itself the power to auction New Zealand units, within an overall cap on the amount of NZUs that are allocated and auctioned.

When this was mooted in an April discussion document, the most common reasons given by many submitters who opposed it were concerns over the impact on NZU prices and that it would reduce forest owners' ability to sell their units.

The objective, Groser says, is to make it redundant for New Zealand emitters to use international units.

Whereas fewer than 150,000 units of import carbon were surrendered in 2010, it had shot up to 11.5 million last year.

Groser regards this as a waste of foreign exchange, but that's a problem only if for some reason the Government could not sell the imported carbon back into the international market once it had been surrendered, or if - contrary to his expectations - the international price continued to fall.

Although the details have yet to be worked out in consultation with stakeholders, auctioning is not seen as a mechanism for managing the carbon price. As long as emitters have the ability to surrender imported units instead, they will be the marginal supply that drives the price.

The Cabinet paper Groser presented to his colleagues last week and which was released yesterday acknowledges a common concern raised by both opponents and supporters of auctioning, that it would increase regulatory uncertainty for market participants.

There is plenty of uncertainty already: what will New Zealand's emissions target be for the next eight years? Will we sign up for a second commitment period under the Kyoto Protocol or just adopt the target unilaterally without a formal treaty commitment to other governments? And in that case would New Zealand emitters and foresters still have access to international carbon markets, which are creatures of Kyoto?

Groser says he will not allow New Zealand to be pushed into decisions on these matters until there is a lot more clarity about what the world's major emitting countries intend to do.

"If the US and China, which between them are responsible for 40 per cent of global emissions, don't do anything then I'm sorry, we are all wasting our time here."